JPMorgan Indian (JII) has published its annual results for the year ended 30th September 2024, during which it produced an NAV total return of 18.1%, underperforming its benchmark, the MSCI India Index by 9.6% (the benchmark returned a hefty 27.7%, outperforming both the MSCI Emerging Markets Index and the MSCI China Index). JII says that nearly all of this underperformance occurred in the first half of the financial year, and is mainly attributable to its managers’ bias towards higher quality corporate names, at a time when lower quality sectors of the market did well. The performance of several portfolio holdings also disappointed over the year. In addition, some areas of the market are now experiencing what its managers believe are unjustifiably high valuations “which have precluded them from participating to any meaningful extent, given their focus on quality”. JII adds that 4.4% of the shortfall compared to the benchmark is attributable to capital gains tax not being included in the benchmark.
Board review of the investment process and performance
Against this backdrop, JII’s board says that it has undertaken a detailed review of the investment manager’s investment process and the drivers of the company’s underperformance, particularly in the most recent period. The investment manager’s process is designed to identify and invest in superior businesses with growth potential which will likely deliver strong absolute returns and outperform over time. This review confirmed that up to the middle of 2023, premium and quality businesses as defined and favoured by the investment manager, had outperformed the broader Indian investment universe, whilst, more recently, cyclical and challenged businesses (again as defined and least favoured by the investment manager) outperformed. In summary, since the middle of 2023 companies with riskier characteristics and cheaper initial valuations have materially outperformed higher quality companies with strong governance. In order to improve their opportunities for relative outperformance, the investment manager has allocated further resource to their Indian equity strategy, by hiring additional analysts on the ground in India to deepen their local knowledge and to promote idea generation via greater market coverage, particularly in the mid and smaller company area. Recognising that many factors remain outside the control of the investment manager, the board says that is minded to allow time for these measures to result in a noticeable improvement in long term relative performance, while continuing to keep performance under close scrutiny.
Revised management fee arrangements
With effect from 1st October 2024, the annual investment management fee, calculated as 0.75% on the first £300m and 0.60% in excess of £300m, will be charged on a market capitalisation basis instead of on a gross assets basis, as previously. The board believes that this change of fee basis will not only be immediately accretive to the company in monetary terms but will also more closely align the interests of the manager with those of the shareholders.
Discount and share repurchases
The discount narrowed slightly to 17.8% over the year (2023: 19.3%). 4,408,623 shares were repurchased during the period, amounting to 4.4% of the shares in issue, and held in treasury. Since the financial year end, the company has purchased a further 1,355,248 shares. As shares are only repurchased at a discount to the prevailing net asset value, share buybacks are accretive to remaining shareholders
Investment manager’s report – market review
“During the 12 months to end September 2024, the MSCI India Index produced a strong positive return of +27.7%, extending the +14.7% return it delivered in the first half. After several weeks of voting, India’s general elections concluded on 1st June 2024. Despite heightened volatility driven by exit polls, markets made gains from the first week of June onwards on the belief that the government will continue with its growth and fiscal consolidation agenda despite not getting an absolute majority on its own. Perceived stability of the BJP-led NDA coalition government and limited changes to the line-up of key economic ministers buoyed investor confidence.
“Small and mid-cap stocks (SMID) have continued to outperform the broader market. We remain concerned about elevated valuations here. Since the elections in June however, we have seen a rotation towards defensive/higher quality sectors due to concerns around a slowdown in growth. With single digit earnings growth for the quarter ending in September 2024, the market took a breather in October; however its strength until the end of September was driven by significant flows into domestic mutual funds. Inflows have risen despite an increase in tax rates on both short-term capital gains on equities (from 15% to 20%) and long-term gains (from 10% to 12.5%). With markets awash with liquidity, it is no surprise that deal activity remains strong, including the recent IPO of Hyundai India.
“Despite strong domestic flows and the longer-term story remaining intact, we feel that Indian markets could take a cyclical breather in the near-term due to: (1) foreign investors withdrawing money from India to allocate to China (in response to the recent rally there); (2) quarterly results coming in below market expectations; (3) upcoming state elections where the BJP was not expected to do well; and (4) growing concerns around overvaluation, especially in the SMID space, now gaining greater traction. However, the long-term structural investment case for India remains on track and any correction might create opportunities for us to buy names where demanding valuations have precluded us from investing.
“Against this backdrop, over the year your Company made a positive outright return of +18.1% on a net asset value basis, which also includes the adverse impact of capital gains tax (more on this below). The share price return over the period was +20.4%, reflecting some narrowing of the discount to NAV.
“In this report we review the main drivers of recent performance, discuss portfolio positioning, and consider the long-term outlook for Indian equities.”
Investment manager’s report – performance review
“Given the strong market backdrop, we recognise that this is a disappointing period of performance relative to the benchmark.
“At this point we believe it is important to highlight the impact of capital gains tax (CGT) in India; it is a pertinent issue for investors and a real cost which does not impact the benchmark.
“The drivers of underperformance can be broken down into three areas: (a) the style rotation away from the ‘quality’ and ‘growth’ stocks we favour to ‘value’, due to a step change in interest rates as inflation rose dramatically post-Covid; (b) too much portfolio concentration in slower growing sectors like private banks, staples and IT, and holdings in some names facing company or sector specific issues; and (c) errors of omission which resulted in underweights to certain high quality names in rapid growth sectors such as fixed asset creation, consumer discretionary and disruptive business models.
“If we consider the ten best performing stocks in the index over that period, six are businesses that we consider low intrinsic value creating businesses, where we also have governance question marks; two are businesses we owned, while two are businesses we believe we should have held but missed (errors of omission).
“With regards to specific stock impact, we would highlight three names which have been disappointing on a relative basis:
- HDFC Bank: The bank faced central bank induced liquidity challenges, which impacted the rate of deposit collection, following its merger with HDFC Limited (a wholesale funded institution).
- WNS: The IT services company that provides business process outsourcing (BPO) to global clients was affected by negative sentiment towards the BPO sector, exacerbated by concerns over the impact of Generative AI and a one-off client loss.
- Hindustan Unilever: The company experienced a slowdown in consumer spending and increased competition from smaller players, impacting its market position.
“On the positive side, our large holding in the auto sector (Bajaj Auto and Mahindra Mahindra), produced very strong positive returns over the period driven by strong earnings growth and improved capital allocation. Our long-standing position in Multi Commodity Exchange (MCX) was also another stand out performer as it managed to go live with a new Commodity Derivative Platform. Our underweights in Bajaj Finance and Asian Paints also contributed positively. We have avoided both names given demanding valuations.”
Investment manager’s report – new initiations
“Blue Star is a leading player in the commercial air conditioning (AC), commercial refrigeration, and room AC segments in India, boasting strong market shares. The company’s DNA is deeply rooted in R&D, enabling continuous innovation and product differentiation.
“CG Power is a manufacturer of industrial products and power equipment. Its product offerings across industrial motors, power transformers and switchgears, is perfectly aligned with the investment priorities of the government around encouraging private sector capex in manufacturing and shoring up power deficit in the county.
“PB Fintech operates India’s leading insurance platform, Policybazaar. It has firmly established its dominance and pricing power in the life and health segments, by offering better quality customers (better persistency and lower claims ratios) to insurance companies. The company’s platform wields significant bargaining power thanks to its high-quality customer base and is further entrenching itself in the customer journey by offering more services such as claims processing.
“Shriram Finance is a quality non-bank financial company (NBFC). It is India’s leading second-hand commercial vehicle (CV) financier and this position, combined with the diversification of its loan book following a merger with Shriram City Union Finance, makes the business more resilient. Growth is being driven by decent pricing in secondhand CVs and +30% growth in loans to micro, small and medium sized enterprises.
“Sundaram Finance is one of the most conservative-run NBFCs in the country with an exemplary track-record on credit costs and governance standards. We especially admire the long-term thinking of the majority owners and management of this business. The company has an impressive track record of compounding growth at 15-17% per annum for more than 50 years, consistently generating an ROE of 16-18% with the lowest non-performing asset (NPA) ratio among its peers. It achieves this by targeting low-risk, high-ticket customers, empowering its salesforce, and expanding its branch network through an apprenticeship model.
“Tech Mahindra is a mid-sized India IT services company. We expect the new management team to turn this business around by significantly improving its cost cadence, through sub-contracting, offshoring and employee pyramid levers, and potentially also improving the growth profile and earnings quality of the business by stabilising market share losses in the telecom sector, mining existing clients more extensively and delivering faster growth in financial services which is the largest IT outsourcing sector globally.
“MakeMyTrip (MMyT) is the dominant online travel agency platform in India, offering both air-ticketing and hotel booking services. The company is well-placed to benefit from increased discretionary spending on travel and leisure. The investment case for MMyT is largely predicated on maintaining its dominant position in the hotel booking business, where barriers to entry are higher and online penetration is lower than in air-ticketing. The company benefits from having aggregated a large, fragmented supply of Indian hotels and from having the largest market share measured by both transactions and value. This ensures a virtuous cycle of consumers transacting on the platform and hotel owners extending their inventory and promotions to MMyT.
“Tata Motors is a leading automobile manufacturer with a portfolio that includes a wide range of personal vehicles, trucks and buses. It is the market leader in the commercial vehicle and personal electric vehicle segments in India. It also owns Jaguar Land Rover (JLR) since 2008, which has two niche luxury British car brands: Jaguar and Land/Range Rover. Tata’s Indian truck and bus business is a great franchise. We expect the company to continue transitioning JLR to a more premium positioning and increase consumer pull in global markets, further strengthen its market position in commercial vehicles and gain market share in the Indian personal vehicle segment, through leadership in EVs, over the medium-to-long-term.”
Investment manager’s report – complete sales
“Maruti’s share of the auto market in India has moderated from 52% in FY2019 to ~43% off currently. While the business generates relatively high ROCEs due to its assembly model, we believe it will keep losing market share to local players like Tata Motors and M&M, as well as to Korean car makers. This is due in part to a premiumisation trend in the country and move towards SUVs, both areas which Maruti does not have traditional strengths in. The company’s high market share base, increasing competition, and its mass-market positioning, mean it will be tough for Maruti to outgrow, or to even keep pace with growth in the auto market. For these reasons, we have sold our position in Maruti and replaced it with Tata Motors, which offers a more unique investment opportunity.
“Power Finance Corporation (PFC): Our initial investment in this government-owned energy infrastructure finance provider was based on high and sustained growth in the power sector, and the lack of alternatives due to valuation constraints in higher-quality product companies and in the power utility space. PFC screened well on economics and the duration of its business model. Being a state-owned entity, we always knew governance could be less than satisfactory, but we believed the government would not compromise minority shareholders, especially given the ongoing reforms to improve the financial health of the power sector. However, several data points since making the investment changed our opinion on governance which could compromise the lending standards and diversification of the business outside of the power sectors. Given these developments, we exited our position.”
